Do Funds Make More When They Trade More?
We model optimal fund turnover in the presence of time-varying profit opportunities. Our model predicts a positive relation between an active fund’s turnover and its subsequent benchmark-adjusted return. We find such a relation for equity mutual funds. This time-series relation between turnover and performance is stronger than the cross-sectional relation, as the model predicts. Also as predicted, the turnover-performance relation is stronger for funds trading less-liquid stocks, such as small-cap funds. Turnover has a common component that is positively correlated with proxies for stock mispricing, consistent with funds exploiting time-varying opportunities. Turnover’s common component helps predict fund returns.
You may purchase this paper on-line in .pdf format from SSRN.com ($5) for electronic delivery.
This paper was revised on April 14, 2016
Document Object Identifier (DOI): 10.3386/w20700
Users who downloaded this paper also downloaded* these: